We flagged the weakness in copper a few weeks ago as a yellow flag, even as the equity market remained giddy as could be. Traditionally, copper has been seen as a global economic indicator due to its use in so much of industry. However, with the dominance of China as the marginal buyer of just about every commodity on Earth the past 5-7 years [May 13, 2009: Commodities - It's China's World: We Just Live in It] , it seems much of the commodity movements nowadays are either due to China's decisions to be "balls to the walls" (or not) in their buying [Mar 23, 2009: FT.com - Chinese Stockpiling Spurs Copper Price Rally] and/or easy money policies + the speculator class + the "financialization" of commodities. That doesn't mean that nothing can be read from commodity movements (or in this case copper specifically) but I'd say it is a far different animal than even 10 years ago.
About 6 weeks ago, we noted a story in FT Alphaville that copper had taken on a strange new body in China, as a form of collateral for financing. From March:
- More worryingly however is that the primary use of copper in bonded warehouse appears to be as a financing mechanism to provide cheap working capital for various types of business often unrelated to the metallic industry.
- Initially via a letter of credit and then by using deferred payment LC, they create a borrowing vehicle. Estimates for the amount of metal tied up in such a way range from 40-80% of total bonded stocks. Our estimates are towards the upper end of this range.
- Property developers (or the property developing arms of conglomerates), appear to be behind the lions share of this type of activity, driven by an unwillingness by domestic banks to extend finance
It appears the Chinese government took note of this "innovation" and has taken steps to stop it. Could it be possible then that the price levels of copper were inflated earlier this year due to the use of it as financing in China, and now it has returned to a more realistic level based less on "banking copper" and more on "doctor copper?" - (click chart to expand)
Via FT Alphaville:
- Goldman Sachs said last month that China’s central bank may have cracked-down on the scheme, which saw Chinese corporates use copper as collateral for new loans. Meanwhile, attention turned to other commodities that could potentially be used by China’s companies in a similar way.
- Here’s Michael Liang, a colleague of all ’round China expert Michael Pettis, with some quick post-mortem detail on the scheme — as told to him by a trader friend: This process stopped a month ago because the PBoC intervened to prevent more copper-based financing. This was the start of the bearish sentiment in copper – the massive demand in China is gone.
- This doesn’t mean however that we can relax. It probably just means that the financial sector will continue to find ways to “innovate” around attempts to rein in credit growth. It also means, I would guess, that total [Chinese copper] imports in the past few months were artificially high, and we should expect lower than “normal” copper imports over the rest of the year. Of course this will put upward pressure on the trade surplus.